Chinese domestic aviation: problems, advantages and outlook.

At first sight the Chinese domestic airline industry does not seem too different from those of America or Europe: a few players dominating the market, regional airlines and burgeoning low-cost carriers. However, further examination reveals a typical trait of the Chinese economy prevalent in the aviation industry as well - it is mostly state controlled. The main Chinese airlines, Air China, China Eastern and China Southern, not only control 80% of the market, but are also owned by different branches of the central and local governments despite being listed on various stock exchanges. All of the companies are forced to compete, but the “Big 3” can be suspected to prefer to do so with each other, rather than “outsiders”.

Air China, China Southern and China Eastern have all posted comparable results for 2013 and the first quarter of 2014, citing similar reasons for their declining profits: lower yields, harsher competition from regional and low-cost carriers, declining numbers of premium travelers and depreciating Renminbi. All carriers face, essentially, the same problems as their operations are based on a similar model - an international hub with few secondary hubs and an extensive network within Mainland China (which they are subsidized to fly).

According to the Civil Aviation Administration of China (CAAC), in 2013, the three airlines altogether officially received subsidies of 433 million Chinese Renminbi ($69.25 million) from the central government in Beijing, theoretically modest compared with other Chinese industries. However, because local governments of smaller cities want to maintain direct flights to the main economic centers of China, they therefore provide airlines with generous support, which accounts for the lion’s share of the industry’s subsidies.

China's skies are becoming ever more crowded, making for constant delays. Anyone who has recently taken a domestic flight in China has experienced the frustration of sitting on an aircraft waiting to depart. Poor air traffic control and lack of capacity at the airports are cited for this phenomenon, but the main reason remains the military’s reluctance to allow commercial airlines to use its restricted airspace for weather diversions. Changes are being implemented and airlines will be allowed to change their flight path from this summer in Northern China, if there are dangerous weather conditions. However, further improvement will take time, since PLAAF will be slow to yield its authority to the commercial aviation.

Although the delays cannot usually be blamed on carriers, the service passengers receive still leaves a lot to be desired. Often, passengers are forced to wait for hours in an aircraft without any explanation or information as to the delay. In numerous cases this has lead to passenger protests and sit-ins. The authorities, not oblivious to these protests, have directed the airlines to provide greater levels of customer service to passengers in case of delays. However, other aspects of the flight experience have improved significantly in the last few years, enhanced by new aircraft orders coming into service.

Another trait shared by all three airlines is debt structure. Almost all debts held by the “big three” are denominated in US dollars; hence any Renminbi movement against the USD can significantly affect companies’ financial results.

Despite these problems, the main question remains, how will “the big three” continue to expand after the recent slowing in the Chinese economy and will they be able to turn a profit without Government subsidies.

China National Aviation Corporation (Air China Group).

Although Air China itself is a smaller airline compared with its main rivals, China Eastern and China Southern, Air China Group is as big as the other three carriers combined. It has a 100% stake in Air China, majority ownership of Shenzhen Airlines, Shandong Airlines, Air Macau, Dalian Airlines, as well as a 30% share in Cathay Pacific (Hong Kong airline holds a 20% investment in Air China). The Group has 497 aircraft, with the majority flying under the Air China, Shenzhen Airlines and Shandong Airlines brands. Air China’s main hub is Beijing Capital Airport, while its secondary hubs are Chengdu and Shanghai Pudong airports.

2013

2012

Change %

Revenue

¥98.18 billion ($15.79 billion).

¥99.47billion ($15.94 billion)

-1.3%

Net profit

¥3.6 billion ($576 million)

¥5.3 billion ($849 million)

-32%

Carried passengers

77.68 million

72.41 million

+7.3%.

Load factor

80.8%.

80.41%

Cargo

1.45 million metric tons

1.46 million metric tons

0.69%

Revenue has decreased in the core market of Greater China as well as Korea and Japan. Net profit might have turned into loss if not for a Renminbi appreciation against the US dollar.

According to CAAC, Air China (the airline) has received a relatively small, 10 million CNY ($1.6 million) subsidy from regional CAACs for flying regional routes and improving accessibility of less economically developed cities. However in reality, according to some reports, the airline received 1.28 billion CNY ($204 million) from local governments. Moreover, this number could actually be higher, since the real data about state subsidies is not made public.

Air China expects a 65% decrease in profits for the 1st quarter of 2014, mainly due to the weakening Renminbi. Moreover, a few days ago, the airline’s Chinese pilots published a public letter demanding equal pay with foreign pilots, reduced hours and better working conditions. On a positive note, Germany's Lufthansa has expressed an interest in a possible joint venture with Air China, but stressed tough negotiations lie ahead before any concrete results can be achieved. Air China has recently started testing free Wi-Fi on its Beijing-Chengdu route and expects to gradually expand this to other flights.

China Eastern Airlines.

This company is the largest airline in Asia, by number of destinations. Both Shanghai airports serve as the airline’s principal hubs, while it has secondary hubs in Xi’an and Kunming. China Eastern subsidiaries are Shanghai Airlines, and a recently announced joint venture with Qantas - Jet Star Hong Kong. The total size of China Eastern Airlines and its subsidiaries fleet are 478 aircraft. In an example of the industry’s close ties, CNAC (Air China) owns 11% of China Eastern holdings. Also it successfully derailed Singapore Airlines’ bid for 24% in CEA in 2008, in order to prevent it from entering the Chinese domestic market.

2014

2013

Change%

Revenue

¥88.25 billion ($14.07 billion)

¥85.25 billion ($13.65 billion)

3.5%

Net profit

¥2.38 billion ($380 million)

¥3.07billion ($491 million)

-22.5%

Carried passengers

79.1 million

73.1 million

8.2%

Load factor

79.21%

79.81

Cargo

1.41 million metric tons

1.416 million metric tons

-0.44%

The company blamed the decline in business/first class passengers and lower yields for its recent poor performance.

China Eastern’s debt structure must be examined, since it is representative of all the “Big Three's” balance sheets. More than 95% of CEA’s 58.35 billion Renminbi debt is denominated in US dollars ($9.35 billion). Therefore, larger currency swings on the Forex Market result in a substantial impact on companies’ financial results. The Yuan’s appreciation against the dollar in 2013 helped China Eastern to remain profitable, but has been in reverse as of this year.

Amongst the Chinese domestic airlines, CEA receives the biggest subsidy from the state. Although the official amount paid by local CAAC offices is only 110 million CNY ($17.6 million), the real subsidy is a lot higher, and should stand at about 1.7 billion Yuan ($2.7 billion).

Recently, China Eastern placed an order for 70 Airbus A320NEO, fuel-efficient, short-haul aircraft, in order to increase the airline’s total capacity by 13 aircraft. The deal is estimated to be worth $6.4 billion. However, the company in its annual report states that the biggest challenge for the future is the rise of domestic low-cost carriers (Juneyao and Spring airlines both have their main hubs in Shanghai), encouraged by the 12th five-year plan.

China Southern Airlines.

China Southern is the biggest carrier in Asia, by passenger numbers (91.79 million in 2013) and size of its fleet (561 aircraft). It operates from its main hub Guangzhou Baiyun international airport, with secondary hubs in Beijing, Chongqing and Urumqi. China Southern is also the world’s largest airline to receive a four star rating from IATA. Guangzhou airport is logistically convenient, since it lies in the center of popular routes, such as Australia-Europe, US-South East Asia, and East Asia-South East Asia.

2013

2012

Change%

Revenue

¥98.55 billion ($16.2 billion)

¥99.51 billion ($15.93 billion)

-1%

Net profit

¥2.7 billion ($451 million)

¥3.8 billion ($608 million)

-27.3%,

Carried passengers

82.17 million

77.3 million

5.85%

Load factor

80.22%

81.8%

Cargo

923 thousand metric tons

890 thousand metric tons

3.75%

China Southern recently stated that it had reduced seat prices to increase its market share, due to increasing competition from the HSR network and regional and low-cost airlines. As in cases of Air China’s and China Eastern, its profits have received a boost from the strong Renminbi.

China Southern is currently the only airline in the world to operate both Airbus A380 and the Boeing 787; and has a promising strategy, based on a large transit hub (with more intercontinental routes expected to be opened up, especially to the US and Europe). Although the airline’s officially-received-subsidy of ¥98.52 million ($15.8 million) does not reveal the full picture, it received much lower governmental support than its rivals.

Outlook.

All in all, the “Big 3” face similar problems in both the short and long run: a slowing economy, fewer premium class travellers, China’s expanding HSR network and Renminbi currency fluctuations. As SOEs, they are continually fighting to increase efficiency and reduce waste whilst compelled to fly unprofitable routes for the “greater cause” of regional development.

Regional carriers, most if which are subsidiaries of the “Big 3’s”, are used as a means to improve already fierce competition in the domestic market and develop the domestic industry. Shandong Airlines, subsidiary of Air China, recently reported a $4.6 billion order for 50 Boeing 737.

However, the main challenge to the “Big 3” arises from the Chinese government’s intention to boost competition, especially through the low-cost carriers. These currently account for only 5% of the market, but airlines can expect this to only grow as infrastructure is put into place such as Beijing’s new low-cost terminal (due to open in 2018), the removal of caps on new aircraft purchases and minimum ticket prices, the building of new airports in 2nd, 3rd and 4th tier cities and the encouragement of financial institutions to deepen cooperation with them. The results should appear in the near future.

Juneyao Airlines and Spring Airlines are planning to IPO in Shanghai, in order to fund their expansions, though the latter was suspended, after some uncertainty regarding its financial results. Jiuyuan, subsidiary of Juneyao, should commence operations from Guangzhou-Baiyun airport in August this year. Spring Airlines, which has been growing 20% annually for the last 10 years, continues to expand internationally not only by gaining slots on the routes like Shanghai - Taipei, but also by setting up a subsidiary in Japan. Jetstar Hong Kong, a subsidiary of China Eastern and Australian Qantas, should begin operation this or next year with 48 destinations in Mainland China. Hainan Airlines, the largest private airline in the country, has renamed its Chongqing-based subsidiary West Air, and turned it into a low-cost carrier.

China’s domestic aviation market is only expected to grow in spite of the current economic slowdown. Whilst all three carriers are looking into possible joint ventures with Western carriers, a move that should improve Chinese companies’ management and operational efficiency, the domestic air travel market will grow with greater development and infrastructure coming into operation over the next few years. Market share will shift away form the larger SEOs towards the new players, whilst remaining under the aegis of the big three. China Brain will continue to report on this topic.